Are service fees paid to overseas-related parties deductible for or exempt from Corporate Income Tax (CIT) in China?

Service fees paid to overseas related parties are deductible for CIT purposes provided they are directly related to the foreign-invested enterprise’s (FIE) business operations, charged at normal market rates, and all applicable taxes have been withheld. This lowers the taxable income for the FIE. The service charges between a China parent company and its China subsidiary must be based on the arm’s length principal. Service fees are subject to value-added tax (VAT) or business tax (BT), as well as other surtaxes, such as urban construction and maintenance tax (UCMT), education surcharge (ES) and local education surcharge (LES).

Services rendered outside China are exempt from CIT, but still subject to VAT and BT. The Chinese company should specify the offshore services that it received in the relevant service agreements and be prepared to clarify the nature of services in case the tax bureau challenges it. If the services are or deemed to be provided in China, the service fees will be subject to CIT at 25 percent, calculated on the deemed profit rate of 15-50 percent. CIT exemption may apply under a double tax avoidance agreement (DTA).

If there is a DTA in place between China and the jurisdiction in which the parent company is incorporated, the services provided in China by the overseas parent company through its employees or personnel may be exempt from CIT, provided the service period falls below a certain time threshold. However, if such activities continue (for the same or related project) for a continuous or cumulative period of more than 6 months or 183 days within any 12-month period, a permanent establishment (PE) will be constituted, and the service income attributable to the PE will be subject to 25 percent CIT. Therefore, the Chinese subsidiary and HQ should carefully manage contracts and related projects in China to assess and mitigate the PE liabilities.